Continue reading...If you have looked at option trading at all, you probably know that the price of an option has two components: intrinsic value and time value. Intrinsic value is easy to understand; time value is much more interesting.
To dispose of intrinsic value first, think of it as the amount of the built-in discount. If I own a call option at the $98 strike price, on a stock that is trading at $100, then exercising that option would get me the stock at a $2.00 discount. This discount (current stock price minus call strike price) is the call’s intrinsic value. The call will be worth at least that amount (except in rare cases we need not be concerned about).
Puts also have intrinsic value (at least some of them do). If I own a put at the $50 strike price on a stock that is currently at $47, the put gives me the right to turn over 100 shares of the stock and receive $50 per share. This is $3 per share more than the stock is worth. I don’t have to own stock to buy puts; anyone can buy them as a...
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